Lost in the narrative

This article was first published in the April 2011 edition of Accountancy Futures journal

Narrative reports were originally conceived to provide valuable business information in two forms. First, there was material of a non‑financial accounting nature that was not covered in the financial statements. Second, there were narrative explanations on the performance, position and (to a more limited extent) prospects for the business, which were based on the financial statements but written in a way more accessible to more people. However, increasingly encumbered by demands for more details, narrative reporting is now suffering from information overload and a box-ticking mentality.

The global debate on the role and scope of narrative reporting has intensified as governments, regulators and businesses have agonised over the causes of the global financial crisis and what to do to prevent another. Few dispute that corporate reports should combine retrospective and prospective overviews of the business model and integrate disclosure of an organisation’s strategy and objectives, business sustainability, governance and risk, along with information on its key performance indicators. The issue is that the present detailed requirements are far from optimal in assisting businesses to provide a coherent report covering the major points and thus to tell their story.

DEBATING THE FUTURE

To try and make this happen, a number of consultations and discussions on the future of corporate reporting are taking place. For example, the UK government has consulted on the future of narrative reporting, including the possible reinstatement of a compulsory Operating and Financial Review (OFR) for companies. Last year the International Accounting Standards Board (IASB) received over 100 comments on its proposals for a voluntary framework to help businesses prepare and present narrative reports. The International Financial Reporting Standards (IFRS) practice statement on management commentary was issued in December 2010. And the European Commission is currently seeking opinions on how to achieve clarity, understandability and transparency in corporate governance practices – issues encapsulated by the moves towards integrated reporting.

In the world of corporate reporting there is often a heavy focus on investors’ views, with preparers relegated to providing information on the practicalities of proposals. Preparers’ views are often dismissed as self-interested, biased to communicating less or good news only. But preparers want to engage with investors and other stakeholders, and ensure that listed companies inform the markets of significant developments as soon as possible. It is the preparers who understand best what is happening in the business and so are in the best position to decide what should be communicated to shareholders.

HITTING THE NOTES

It is therefore vital that the views of the preparers of narrative reports help define the debate, which is why a recent ACCA/Deloitte survey, Hitting the Notes But What’s the Tune?, sought the views of finance heads. It asked 231 CFOs, group finance directors and equivalents in publicly accountable companies across nine diverse reporting environments (Australia, China, Kenya, Malaysia, Singapore, Switzerland, the UAE, the UK and the US) to identify the drivers of narrative reporting, the areas most valuable to users, and how reports could be improved.

The survey, undertaken between April and June 2010, reveals that narrative reporting in 51% of businesses is driven by the finance function. However, while it identifies shareholders as the most important perceived audience (88%), followed by regulators (67%), it is also clear that the requirements of both are seen as equally important (82% and 83% respectively). But if both shareholder and compliance requirements drive narrative reporting, are those requirements compatible? And if not, which are given preference?

Finance leaders believe that shareholders want explanations of financial results and position (87%), disclosure of the most important risks and their management (67%), plans and prospects (64%), a description of the business model (60%), and key performance indicators (58%). Yet the top three actual disclosures in reports are explanations of the company’s financial results and financial position, corporate governance policies and procedures, and the directors’ remuneration report. In other words, while shareholders may indeed be the key perceived audience, the form and shape of narrative reporting is actually determined by the legal and regulatory requirements in the different jurisdictions, just as it is for the financial statements.

Regulators need to evaluate whether regulation enhances responsibility in reporting. It could be that compliance with the detailed legal requirements merely adds to complexity for users of reports, obscuring meaningful information about the business model in a mountain of detail. If better, rather than more, disclosure is the way forward, the question is how the needs of shareholders and regulators can be satisfactorily integrated in one report.

A WAY FORWARD

Many finance leaders think that the usefulness of narrative reports could be enhanced by the inclusion of an external auditor opinion (58%), more emphasis on forward-looking information (57%), and guidance from IASB (51%). But the strongest response on how to improve current reports came from the 65% who would prefer a reporting environment with more discretion and less regulation.

It is understandable that, as a result of the financial crisis, regulators want to ensure there is greater transparency and accountability in reporting. But this vision could be better realised by nurturing a corporate reporting culture founded on trust between reporters, regulators and users, and shared responsibility rather than box-ticking. By engaging more with shareholders and preparers, regulators could align disclosure requirements with shareholders’ requirements or make use of the corporate report mechanism.

The way forward may lie in integrating the needs of users and regulators with preparers’ perspectives. Narrative reports could be built on high-level frameworks and principles while giving preparers discretion to provide the details needed by key audiences, and rewarding transparency and accountability. The economic slowdown may well be a time for mapping the future shape of narrative reporting.

Whatever the outcome, the current position is unsustainable. The ACCA/Deloitte report likens the situation to the comedy sketch where the pianist André Previn meets the comedian Eric Morecambe. Previn plays a classical piece beautifully, followed by Morecambe giving a discordant rendition of the same work. Accused by Previn of hitting the wrong notes, Morecambe ripostes that he did indeed play all the right notes, just not necessarily in the right order. For narrative reports to be music rather than so much noise, the current score will have to be revised.
Professor Isobel Sharp CBE is a partner at Deloitte, where she specialises in corporate reporting and governance. She was president of the Institute of Chartered Accountants of Scotland for 2007/08, is a visiting professor at the University of Edinburgh Business School, and is a board member of the Independent Parliamentary Standards Authority

Dr Afra Sajjad is the head of education and policy development, ACCA Pakistan. She also oversees education initiatives aimed at giving students study support and leads ACCA’s narrative reporting technical work. She has a doctorate in financial reporting from Dublin City University, and her research interests include corporate governance, ethics and Islamic finance